The issuance by the Administration of its long-awaited paper on reforming government-sponsored entities (GSEs) on February 11 has substantially changed the playing field for the housing finance reform. The following are some first takeaways:

For the first time in 70 years, an administration—and a Democratic one at that—has pulled its support from Fannie Mae and Freddie Mac, and done this at a time when they, along with the Federal Housing Administration (FHA), is the only support for the feeble housing markets. This means that the question is no longer whether Fannie and Freddie will survive in some form; the focus is now on how and when they will be wound down and what will replace them. This eliminates a huge and very contentious issue from the debate, but raises major questions. The time frame for winding down Fannie and Freddie was given as five to seven years, though this may be optimistic.

To answer one of the questions raised by the coming demise of Fannie and Freddie, the Obama administration said repeatedly that it would stand behind all existing and future guarantees and all outstanding and future debt issued by them. This was critical to maintaining an AAA rating for the debt and guarantees, and was noticed appreciatively by China, a major holder of this paper.

The paper for the first time in 70 years backed away from an all-out commitment to homeownership. It acknowledged the importance of ownership, but placed great emphasis on rental housing. That said, after noting that efficient financing for multifamily housing is important to low- and moderate-income families, it gave little guidance on what its future might be. Today, Fannie, Freddie, and FHA finance virtually all multifamily debt; all the administration’s paper had to say was that perhaps the FHA could expand its role in multifamily finance—essentially a non-answer.

The paper laid out a short- and long-term path that it acknowledges will raise the cost of mortgage financing. In the short term, the paper says that the administration will ask the Federal Housing Finance Authority (FHFA)—Fannie’s and Freddie’s overseer—to have Fannie and Freddie increase downpayment requirements to a minimum of 10 percent and to increase their guarantee fees. Theywill also let the conforming loan limits drop back to $625,500 on October 1. They will look at similar ways to reduce the FHA’s role in the single-family market. The goal is to begin to make room for the re-emergence of a private mortgage market, without disrupting further the weak housing markets. This will help inform the debate in Congress going forward; if the private market does begin to revive, legislators may have more leeway in constructing a new federal role.

The paper suggests three broadly defined alternatives to replace Fannie and Freddie. All three include the continuation of FHA, Veterans Administration (VA), and U.S. Department of Agriculture (USDA) mortgage programs for low- and moderate-income families but at a lower volumes, back to the 10 to 15 percent share of the market they had before the crisis, not the 30 percent or more share they have now.

Option 1 is to have no government involvement other than the FHA, VA, and USDA.

Option 2—which might be called the Brigadoon Option, after the mythical Scottish town that appears once every 100 years—allows for a government insurance program, but one designed to be noncompetitive except in times when the private capital markets are frozen (like today) or have tight limits on volume, which could be increased when needed.

Option 3 is to charter the creation of private mortgage securities guarantee companies that would guarantee pools of mortgage securities issued by others. The companies would charge a guarantee fee, part of which would be paid to a new catastrophic guarantee fund held and fully backed by the federal government. The government would set the standards for the mortgages that could be included in the pools guaranteed by the private guarantee companies. This way, the government guarantee would stand behind the owner’s equity, the guarantee company’s capital, and the catastrophic risk fund.

A big unknown is what might happen to the huge To Be Announced (TBA) market. At this time, it is based solely on Fannie and Freddie mortage-backed securities (MBS) issuances. When Fannie and Freddie disappear, will it as well, or can it continue under the options laid out in the administration’s paper?

There is much more in the paper. It is thoughtful and clearly written, and adroitly punts the ball on the reform of the housing finance markets back to Congress. It does begin to shape the debate as it has taken the ultimate future of Fannie and Freddie off the table. Many are guessing that if the administration “had its ’druthers” it would chose option 3, but there will need to be very broad and deep support for that option among all stakeholders for that to become the consensus view. This includes homebuilders, mortgage bankers, real estate agents, and Wall Street. This is a process that is likely to take at least the next two years. If, as everyone hopes, the housing markets are showing signs of strength and stability in 2012 following the Presidential election, it may be possible then for legislation laying out the future to move forward.

From now until 2012, there will be a lot of action. There will be many hearings in the House (which already held its first hearing a week ago) and the Senate on the future of housing finance. There will continue to be white papers coming out of think tanks and proposals in ever greater detail from industry groups.

Even more important, in accordance with the requirements of the Dodd-Frank Act the administration will be proposing new regulations on qualified residential mortgages (QRMs) this year. These will define what mortgages can be pooled into MBSs without originators or securitizers retaining any risk. Also to come are the rules for how the risk to be retained by originators and securitizers will be defined. There is also a host of consumer protection and transparency rules on the way.

This is an unprecedented period in housing finance; there will be more change in this arena than at other any time since the 1930s. It is now clear that underlying these changes is a seismic shift in federal policy away from wholehearted support for homeownership and toward a new and yet to be determined balance between owning and renting. Homeownership will likely remain an aspiration for many American families, but it will cost more, take longer to achieve, and be unavailable to more than in the past two decades. This is the underlying message of the Obama administration’s paper.

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